HONG KONG Feb 20 Swiss investment bank UBS faces a 10-fold rent increase in the world's most expensive city for office space, as the main lease on its Hong Kong offices nears its end.
The bank has enjoyed a sweetheart, 10-year lease on space in Two International Finance Centre, which dominates Hong Kong's Victoria Harbour skyline, in a deal struck when the city was staggering from one of its worst economic crises.
UBS has limited options, property sources said, and is set for some tough negotiations with its landlord, the MTR Corp , which runs Hong Kong's subway and owns the main space UBS occupies.
Unlike rivals Morgan Stanley, Credit Suisse and Deutsche Bank, which all struck fresh Hong Kong leases in a new building in recent years, the pressure is on UBS to sort out its space needs in Asia's financial capital.
Although record office rents are dipping in Central - the heart of Hong Kong's financial district - property professionals say UBS will have to swallow the higher rent to stay in Two IFC.
"They're paying HK$3 million a month, and that could go up to HK$30 million," one broker said.
Over a year, that monthly increase could cost UBS an extra HK$324 million ($42 million).
Occupancy costs account for only around 8 percent of an investment bank's expenses, and $42 million may not seem like much to an institution valued at $54 billion. But UBS is in a major, global cost-cutting programme, so the prospect of a big rent hike in such a large banking operation is ill-timed.
UBS are "going to be pretty much hostage," a Hong Kong-based property specialist at a rival investment bank said. "They're not going to have a ton of options. Nine out of 10 chances they're going to stay there."
The Swiss bank and MTR declined to comment for this article. None of the six commercial brokers interviewed for this article wanted to be identified as they work with investment banks in Hong Kong.
UBS, which employs 2,300 people in Hong Kong, leases other, smaller space in the city, though most of its operations are in Two IFC. The landmark skyscraper, the tallest building on Hong Kong island, was completed in 2003, the year Severe Acute Respiratory Syndrome (SARS) and recession ravaged the city. That saw a bottom in the real estate market, which hadn't recovered from a bubble that burst in 1997.
Faced with letting 2 million square feet in the 88-floor building at such a time, its developers struck deals that now look shockingly low.
The building was jointly developed by the MTRC and a consortium of Sun Hung Kai Properties, Henderson Land Development and Hong Kong & China Gas Co, with the Hong Kong Monetary Authority buying the top floors.
As an anchor tenant, UBS signed with the MTRC in November 2003 to rent 146,070 square feet across six floors at HK$4.7 million per month, fixed for 10 years - a long lease for Hong Kong. That works out at HK$32 per square foot.
"They got a phenomenal rent," a property investment banker said. "They went in there when Two IFC looked like a big white elephant. MTRC just dropped their shorts on the UBS lease because they were scared they weren't going to be able to lease the space."
There were sweeteners, too. A copy of the lease obtained by Reuters shows UBS was granted 41 rent-free months, meaning it only pays rent two-thirds of the time. That cuts the effective rate to HK$3 million a month, or HK$21 per square foot.
And, property brokers say, the company received large subsidies from the MTR to fit out the space, inducements not on the lease, reducing the effective rent to HK$15 a square foot.
Jones Lang LaSalle, which now represents UBS in Hong Kong, and Savills declined to comment on the lease specifics, citing confidentiality agreements with the bank.
"It was one of the better anchor tenant deals at the time," said Chris Marriott, now CEO of Southeast Asia at Savills. Marriott brokered the original lease.
UBS has since expanded at Two IFC and rents around 200,000 square feet from MTRC on eight floors. The lease on its core six floors, which allowed it to expand into a seventh at the same rent, expires on June 30, 2014. The bank has an option to renew for another five years, at the open-market rent.
Large tenants work on rent renewals several years in advance, which is why UBS is addressing the issue now, sources say.
The asking rent in Two IFC is HK$180 per square foot, according to brokers. As a flagship tenant, UBS could command a discount of around 15 percent. But that leaves it facing a rent of around HK$150 per square foot.
UBS has played hardball before.
After Blackstone bought a half share of the 30-acre Broadgate development in London in 2009, UBS, the largest tenant, threatened to leave. It opted to stay when Blackstone and co-owner British Land agreed to knock down two buildings and develop a bespoke 700,000 square foot London headquarters for the bank.
A new building would not be ready by the time UBS' lease ends in Hong Kong. Landlords are not offering cash incentives for fitting out or rent-free periods, with Savills tracking a Central vacancy rate of 3.2 percent in January.
"For the next 2 or 3 years, we won't see any of that happening," a broker said.
According to Colliers, only the redevelopment of the Ritz Carlton Hotel, mostly taken up by China Construction Bank , and the redevelopment of The Forum by Hongkong Land will come on the market in Central through 2014.
The International Commerce Centre (ICC), now home to the main Hong Kong offices of Deutsche Bank, Morgan Stanley and Credit Suisse, is close to full. "There's no block of 140,000 square feet available," said a broker who has worked with UBS on its leases.
UBS also rents space in Central in the buildings Li Po Chun Chambers, and One and Two Exchange Square. Another broker who works on bank leases in Central said he expects UBS to give up that space when those leases expire and move its back-office operations outside Central, and to renew in Two IFC.
"If I was the IFC landlord, I'd sit until 2014 and wait," that broker said. "Rents will probably have come back by then. And there's a decent possibility UBS has few options to manoeuvre."
($1 = 7.7541 Hong Kong dollars) (Editing by Michael Flaherty and Ian Geoghegan)